A move by the Securities and Exchange Commission this week opens up huge new doors for ancillary cannabis startups seeking money while also making it easier for investors to find opportunities in the marijuana industry.
The SEC essentially agreed to let entrepreneurs use advertising as a way to raise financing in certain circumstances, lifting a ban that had been in place for decades. Translation: Startup companies and even hedge funds will soon be able to pitch wealthy investors via everything from billboards to television and radio ads. A company that provides software to marijuana dispensaries, for instance, will be able to run an ad saying that it is looking for a $100,000 investment in exchange for a 30% stake in the business.
The catch: Only individuals who make more than $200,000 a year ($300,000 for married couples) or have a net worth of at least $1 million can invest, and the startup will have to notify the SEC that it is seeking investments. Additionally, investors will have to jump through more hoops.
The move is part of the rule-making process tied to the Jumpstart Our Business Startups (or JOBS) Act, a law enacted last year as part of a bid improve the funding climate for small companies in the US.
Khurshid Khoja, a principal at Greenbridge Corporate Counsel, spoke with MMJ Business Daily this morning about the impact of the development on the cannabis industry. (Note: You can read about the specifics of the SEC decision here and check out columns by Khoja exploring the JOBS Act last summer here and here)
Question: The SEC action applies to the general US business community, but what does it mean specifically for the medical marijuana industry?
Answer: For medical cannabis businesses, this definitely makes it easier to raise capital because they don’t have to rely as heavily on introductions and forums to meet investors. They can put out a Youtube video potentially, or have an offering listed on a website and circulate information that way, or even talk to the press. Before, a small company that wanted to sell securities under exemptions to SEC registration requirements could not engage in any advertising for their private offering. All communications of this nature would have to be to prospective investors – a company couldn’t use any means that would essentially be accessible to the general public.
I have a client that has become a media darling, and I’ve had to lecture the founder on what he can and can’t say about his fundraising activity. Now in theory he doesn’t have to worry about it as long as he complies with the other requirements of the new registration exemption under Rule 506(c). He can talk to the press about how much money he is raising and there’s less of a likelihood that the SEC would look at him crosswise.
Q: On the other side of equation, what does this mean for investors?
A: This will in many senses democratize the investing process, so you won’t have to necessarily be an industry insider to be privy to these deals. For example, right now you have groups like the ArcView Angel Network, and most of the investors with them are industry insiders who have industry know-how and connections. Now, with companies advertising their own offerings, investors don’t necessarily have to go through angel investor groups to find these deals. If you do your due diligence, you will be able to find these deals. That said, investors going it alone, without the benefit of experienced colleagues with industry knowledge, could easily be defrauded or worse by dishonest issuers taking advantage of investor enthusiasm. At the end of the day, the new rules will definitely increase the investor competition for deals.
But any company that is taking advantage of the new rule is going to have to verify that investors are actually accredited. That means investors will have to submit tax returns or other documentation that substantiates their net worth or income. Before the investor could essentially just fill out a questionnaire and check the box next to their status. Now they’ll actually have to submit documentation.
Q: What types of cannabusinesses will be able to take advantage of this change?
A: Under the Controlled Substances Act, financing core cannabis businesses like dispensaries is still illegal. Realistically speaking, this will benefit ancillary companies (such as software firms, equipment manufacturers and others who provide products an services to the industry but don’t actually handle cannabis). But even then there are still federal rules on paraphernalia that apply to such investment activity.
This is also really aimed at startups, because they would be making a private offering, not public companies. We’re talking small companies engaging in private equity deals.
Q: So this only involves deals in which a company is looking to give up equity for financing?
A: It’s not just equity. This encompasses debt instruments as well, for example convertible debt, where investors are buying a promissory note that converts to equity at some point.
Q: Can businesses begin advertising their funding proposals now?
A: No. The rules have to be published in the Federal Register, and then they would take effect 60 days after that. The SEC has also issued a new rule proposal that would require a company to file a Form D 15 days before they plan to advertise the offering and disclose other information, such as the details of the nature of the offering and how they are going to advertise it. If this rule is adopted then you can’t just put an ad in newspapers saying that you’re selling shares without first notifying the SEC, and you’ll have to include certain disclosures to prospective investors in written ads. It will probably be mid-September at the soonest before we’ll see this take effect.